MODELISATION, ESTIMATION ET ANALYSE DE L’INTERACTION ENTRE

DETTE ET CROISSANCE ECONOMIQUE AU CAMEROUN

(Modeling, estimation and Analysis of The interaction Between Public

Debt and Economic Growth in Cameroon)
TINANG NZESSEU JULES VALERY
Statistician and Economist Engineer
E-mail: tinzeus2003@yahoo.fr
KANA KENFACK CHRISTOPHE
Statistician and Economist Engineer
National Institute of Statistics
P.O. BOX 134 Yaoundé – Cameroon
E-mail: christkana@yahoo.com

Abstract
In this paper, we intended to model, to estimate and to analyze the relation between the debt and the economic
growth in Cameroon in order to value what could be the fallouts of an annulment of the debt and how to pull profit of it.
Indeed, theoretically the debt certainly constitutes for a country an opportunity to increase its production and to face its
temporary difficulties. But it can also present some inconveniences for the growth and the investment; this generally, when
it is located beyond a certain threshold identified by the curve of Laffer. These negative effects appear through the
virtual burden of the debt, the constraint of liquidity and the uncertainties that it can generate. For the realization of our
survey, we had resort to a VAR modeling founds on a neoclassical growth model to which we added the variables of
opening and the debt. After estimations and analysis on Cameroon’s data, the gotten results invalidate the hypothesis of
the virtual burden of the debt and confirm the one of the eviction of the investment due to the service of the debt.
Besides, the level raised of the Cameroon’s external debt would be owed both to the crisis of 1987 and to the
devaluation of the CFA Franc in 1994. In fact, the stock of the debt has a positive impact on the economic growth in
Cameroon, but doesn't influence the investment meaningfully; it translates a use of the debt at ends of consumption that
could compromise the future repayment of the debt. A debt relief would be beneficial if it drags a considerable and
immediate reduction of the service of the debt, and facilitate the access to new loans. These loans should be used for the
financing of the investment in order to guarantee a sustainable growth and to facilitate the repayment of the debt.
Key words: External public debt, ricardian equivalence, VAR modeling.

Résumé
Dans cette étude, nous nous proposons de modéliser, d’estimer et d'analyser la relation entre la dette et la croissance
économique au Cameroun afin d'évaluer quelles pourraient être les retombées d'une annulation de la dette et comment
en tirer profit. En effet, théoriquement la dette constitue pour un pays une opportunité d'accroître sa production et de
faire face à ses difficultés temporaires. Mais elle peut également présenter des inconvénients pour la croissance et
l'investissement ; ceci généralement, lorsqu'elle se situe au delà d'un certain seuil identifié par la courbe de Laffer. Ces
effets négatifs se manifestent à travers le fardeau virtuel de la dette, la contrainte de liquidité et les incertitudes qu'elle
peut générer. Pour la réalisation de notre étude, nous avons eu recours à une modélisation VAR fondée sur le modèle de
croissance néoclassique auquel nous avons ajouté les variables d'ouverture et d’endettement. Après estimations et
analyse sur les données du Cameroun, les résultats obtenus infirment l'hypothèse du fardeau virtuel de la dette et
confirment celle de l'éviction de l'investissement due au service de la dette. De plus, le niveau élevé de la dette
extérieure du Cameroun serait dû d'une part à la crise de 1987 et d'autre part à la dévaluation du FCFA en 1994. En
fait, le stock de la dette a un impact positif sur la croissance économique au Cameroun, mais n'influence pas
significativement l'investissement ; ceci traduit une utilisation de la dette à des fins de consommation et pourrait
compromettre le remboursement futur de la dette. Une annulation de la dette serait bénéfique si elle entraîne une
réduction considérable et immédiate du service de la dette, et facilite l'accès à de nouveaux prêts. Ces emprunts doivent
être utilisés pour le financement de l'investissement afin de garantir une croissance durable et de faciliter le
remboursement de la dette.
Mots clés : dette publique extérieure, équivalence ricardienne, Modèle VAR.
1

Electronic copy available at: http://ssrn.com/abstract=1666844

 1. introduction

External debt is often considered as one of the major causes of low economic performance
and growth retardation, recorded by developing countries (DCs) in general and those of Sub-
Saharan Africa (SSA) in particular, during the 1970s and 1980s (Sachs (1989), Fosu (1996); Iyoha
(1999)). The pattern of accumulation of debt in these countries is almost the same and could be
resumed in a simplified way as such: Everything starts with a wave of emancipation and
development needs which push the leaders, given the weakness of domestic savings, to look
outward in order to borrow additional funds to carry out their development projects. Subsequently,
an economic crisis whose origin is external or internal occurs, causing a country's inability to
service its debt. Thus begins the spiral of indebtedness that brought the country to borrow to service
its passed debt and led to its inability to repay its debt for which the remaining solution seems to be
a cancellation of debt by creditors.

Like many developing countries, Cameroon has experienced the phenomenon of debt that
has led to an explosion of foreign debt estimated at 106.7% of Gross National Income (GNI) in
1994. In 1996, the initiative for Heavily Indebted Poor Countries (HIPC) was launched by the IMF
and World Bank as a result of numerous attempts to reduce the debt of developing countries so far
undertaken by bilateral creditors (Paris Club) and private (London Club). Cameroon joins the
process in 1997 after several previous attempts to resolve its debt problem, including among other,
numerous debt rescheduling and the adoption of the Structural Adjustment Policies (SAPs)
proposed by the Bretton Woods institutions (the IBW). The HIPC initiative has had a considerable
impact on the level of Cameroon's public debt through the cancellation of external debt, allowing
the government to regain a state of debt equivalent to the 1980s. Indeed, after the implementation of
debt relief granted by bilateral and multilateral creditors, there is a reduction of external debt of
2.263 billion FCFA, which made it to decrease from 3652.1 billion in 2005 to 1015.6 billion FCFA
in 2006 and to represent 18.23% of GNI the same year.

On the other hand, after its independence in 1960, Cameroon has experienced a growth
phase of an average rate of 6% until 1986. Subsequently, the country will be affected by a series of
external shocks, including the overvaluation of the currency and deteriorating terms of trade,
marked by falling prices of oil and agricultural commodities (cocoa, coffee). The rate of growth
during this critical phase, which will go until 1994, is generally negative and is about -3.8%. After
2

Electronic copy available at: http://ssrn.com/abstract=1666844

the devaluation of the CFA occurred in January 1994, the country will renew with positive growth
the following year with a rate of 3.3%. The average growth rate of real GDP is around 4.1%,
although a marked decrease (3.81% over the period 2000-2006 and 3.22% in 2006) over the last
five years of the decade 90.

Of these two developments, he exudes a certain negative correlation between the evolution
of Cameroon's external debt and that of its economic growth1. So, can we say in the case of
Cameroon that external debt has impeded with economic growth? More generally, is the relative
weakness of economic growth a cause or a consequence of external debt? The answer to both
questions will be the subject of this paper whose aim is to evaluate the effect of the cancellation of
external debt on economic growth in Cameroon and to identify measures to benefit from it.

For the rest of the article, we begin with a brief review of the literature to explain the
theoretical and empirical links far identified between external debt and economic growth (2.). Then,
we present the econometric model developed to capture this relationship (3.). After presenting the
basic data used (4.), we present the estimations’ results and interpretations deriving from it (5.). We
end with a conclusion in which recommendations will be made (6.).

2. Literature Review On The Relation Between External Debt And Economic Growth

Many theoretical works in 90s2 on economic growth tend to support the idea that poor countries
have the opportunity to grow faster than rich countries; this is partly because of their growth state
relatively far from the steady state3 and partly because of technological transfer which they could
benefit from the developed countries4. However, developing countries, particularly those in Africa,
face many difficulties and constraints on economic growth. The debt of these countries would be
one of the factors contributing to weak economic performance. In fact, there is a two side’s
relationship between debt and economic growth of a country, because a high level of debt can be
the result of weak economic growth, as can be the cause. This interaction has been the subject of
several theoretical and empirical developments in recent years. On the one hand, the impact of debt
on economic growth can be seen through several phenomena such as the debt overhang, the

1
This can also be observed on the Figure 1 provides in Annexe.
2
See Barro and Sala-i-Martin (1996).
3
Indeed, countries with low capital per capita have more opportunities of investment and they are more profitable.
4
Further than any other country, Japan has taken advantage of this effect during the “great age” period from 1950 to
1973 (Hanel and Niosi, 1998).
3
liquidity constraint of the government and the uncertainties related to future5 (actions of the
government to reimburse its debt) (Presbitero, 2005). On the other hand, slower economic growth
plays an important role in the process of indebtedness (Easterley, 2001).

2.1 The implications of the debt for the economy of a country

The debt incurred by a country may be the cause of many malfunctions in its economy. But
economists agree on the fact that this negative impact appears only beyond a certain threshold.
Below, the debt may be a lever for investment and production.

The benefits of debt

According to Keynesians, under the assumption of underemployment of production capacity,

any productive investment leads by the multiplier effect, to an income’s increase and promote a
demand stimulus. Thus, according to this view, external indebtedness particularly in the case of
LDCs cannot generate costs neither for this generation, nor for the future, because through the
investment process driven by demand, production will increase and will generate the funds needed
to repay debt. External debt would even be the opportunity for an economy in need of capital (with
lack of domestic savings) to start a revival of its production.

Moreover, in its original conception, the debt allows any agent to make economic achievements
of which the cost is higher than its present financial capacity, so we can say that ambition is the
source of the debt. For a state wishing to develop, it would be unwise to use a single machine to
produce while the use of two increase production and improve the economic situation. Thus, the
debt can improve economic performance and achieve faster development goals. The story illustrates
this positive aspect of debt, through the Marshall Plan, which allowed Europe destroyed by war to
rebuild quickly thanks to loans from the United States, without this injection of funds, this
reconstruction would probably have taken much longer. Other examples of the positive contribution
of external financing can be highlighted in the case of Asian countries.

Another positive aspect of debt is that it can overcome temporary difficulties. Indeed,
governments often face a gap between planned spending (incompressible expenses) and the
achievement of planned revenues. This cyclical gap is even more difficult to forecast because it may
result from many factors exogenous to economic activity (natural disasters, climatic disturbances,

5
See Presbitero (2005) for definitions and literature review on those phenomena.
4
falling prices of major exports, etc.). What can cause social troubles and cause lasting damages to
the economy. With the funds contracted, the state may finance the budget deficit and maintain the
internal stability of the country. Seen in this light, international loans can even be seen as an
international solidarity mechanism.

Debt as a hindrance to development

Over time, it was found that the debt could be addictive and that in many cases (especially for
the countries of sub-Saharan Africa), akin to a quicksand in which the states sank more and more
struggling to get out. This confirms the classical economists' skepticism regarding the positive
effects of debt. Indeed, the conventional view is that any debt-based growth would be "virtual" and
eventually would be biased by the behavior of economic agents (altruistic) who, anticipating a
future repayment of debt, are not encouraged to consume and save for future generations (Barro,
1999). Thus, instead of constituting a propellant for the economy, debt through several mechanisms
may act as a constraint to the growth of the country.

First, according to the principle of Ricardian equivalence, the debt is tantamount to a tax on
future income (Op. Cit., 1999). This design would serve as an argument against the policies of
Keynesian stimulus, first through the debt overhang’s phenomenon, and partly because of rational
expectations conducted by companies and households. Thus, any policy of increasing public
spending (public investment, higher wages in the public service, etc.) based on the debt is perceived
by firms and households as higher future taxes to repay this debt, which leads to discouragement of
private investment for the former and the rigidity level of consumption among the latter, thereby
skewing the policy stimulus initiated by the State.

Then, at any time, among other factors, investors consider all the obligations of government to
determine the risk premium and assess the profitability of investments (Alioglu and Can Erbil,
2004). The more government is indebted, the higher is the risk premium on investment, especially
because of uncertainties looking at Government’s future actions. In fact, debt has induced an
additional tax that reduces the returns on investment and discourages capital formation in highly
indebted countries (Karagol, 2002).

Finally, history has shown that external debt could be a springboard for tyranny in despotic
governments whose laxity had led their country into an impasse. These governments have used debt

5
as an asset to bring down national movement and to better control the people; the borrowed funds
being redirected to the developed countries to purchase weapons or to be stored in bank accounts.
These debt situations described as "heinous" pushed the economy of these countries through civil
wars and leave these people with the burden of debt repayment.

2.2 The impact of debt on economic growth

The debt overhang

The debt stock has a disincentive effect on investment through the phenomenon of “debt
overhang”, which occurs when the level of debt is so high that the future service of debt is an
increasing function of production (Arnone & al, 2008). Krugman (1988) defines the debt overhang
as a situation in which “the amount of debt owed by one country is higher than the values expected
of its future repayment”; in this situation, the creditor has the choice between two options: either
cancel the additional amount of debt that the country cannot pay back or grants new loans to enable
the debtor country to pay the debt service, hoping that the future improvement of the economic
situation will allow him to recover the owed funds. The phenomenon of debt overhang is illustrated
by the Laffer curve, representing the payment of debt service on the basis of the stock of debt in the
form of U-reverse (Cordella & al., 2005). Beyond a certain level of external debt, the payment of
debt service is reduced when debt increases. In this situation, the private and public investments are
also reduced because of the “external” tax on production imposed by foreign. Economic theory
states that a partial cancellation of the debt will then increase not only investment but also the
country's ability to repay its remaining and future debts, and would therefore be beneficial for both
the debtor and the creditor. This idea is behind the initiatives of debt cancellation for developing
countries put on in recent years. However, the results of empirical analysis of the impact of debt on
the economy are not unanimous with regard to developing countries.

In fact, some authors confirm the negative impact of debt on private investment in some
developing countries (Borentsztein (1990), in the case of the Philippines; Iyoha (1999), in the case
of countries of sub-Saharan Africa; Mbanga and Sikod (2001), in the case of Cameroon; Were
(2001), in the case of kenya). Presbitero (2005) considers the relationship between growth and debt
is linear and negative and he justifies this by the fact that his study focuses on developing countries
where external debt is assumed to have a negative effect considering their level of indebtedness.

6
The positive relationship between debt and growth (left side of the Laffer curve) would be valid
only in the case of low indebted countries and some industrialized countries.

However, several empirical studies tend to refute this hypothesis in the case of HIPC. The
results obtained by Cohen (1996) by analyzing the correlation between debt and investment in the
countries of sub-Saharan Africa during the 80s showed that the level of debt does not explain the
significant slowdown in investment during this period. Arslanalp and Henry (2005) argue that the
weakness of private investment in the HIPCs is due to lack of infrastructure and favourable
economic institutions. In addition, the ongoing assistance to these countries by the international
community (IFIs, bilateral and multilateral aid) through net positive transfers and constant debt
restructuring, weakens the hypothesis of a reduction in investment due to Virtual burden of debt
(Arnone et al, 2008). Referring to the debt Laffer curve, Cordella et al. (2005) suggests that the
assumption of debt overhang would only be valid for the non-HIPCs, because beyond a certain
threshold, there is an area where the level of debt has no effect on capital accumulation.

The liquidity constraint (crowding-out)

The payment of debt service requires the government to make trade-offs given its budget
constraint. It is induced to reduce its spending on physical and human capital so as to meet the
requirements of its debt’s service. This effect is called an "extended debt overhang" and is
manifested by a “poor allocation of government resources for investment, a short-term vision, lack
of structural reform, and consequently low economic efficiency” (Arnone et al., 2008). The
empirical analysis on the effect of liquidity constraints are less controversial and confirm the
impediment to investment generated by the debt service (op. Cit., 2008). Thus, through its service,
debt requires the debtor to reduce its capital spending6, especially in human capital, and adopt a
short-term vision leading him to seek quickly rentable investments for loosening the budget
constraint. However, these investments can not afford a sustainable economic growth over the long
term.

Some authors (Pattillo et al. (2002); Presbitero (2005)) suggest, through empirical studies on
developing countries, that the negative effect of debt is more evident through the quality and
6
The table 1 in ANNEX shows the share of the budget allocated to social services and debt service in some developing
countries, we find that in these countries over the period 1992-1997, average 10.72% of state budget is allocated to
social services and about 33.02% for the payment of debt service. Thus, those countries whose social conditions are
precarious exported nearly three times much money to wealthy economies than they use to improve the social
conditions of their populations.
7
efficiency of investment rather than its quantity. Thus, weak investment returns due for example to
increasing taxes or cost of credit would be the main obstacle to economic growth.

Liquidity constraint may also be considered by the fact that the purchases made by developing
countries in capital goods or consumption outside are in foreign currencies, which they have only a
fairly limited amount due to the low competitiveness of their economies. Most countries called
Highly Indebted Poor Countries (HIPCs) are not just facing a solvency problem but a problem of
illiquidity (Were, 2001).

Future Uncertainties

The high level of debt creates uncertainty among investors about the future measures adopted by
the state to repay its debt and causes a loss of credibility of the state that can lead to sudden capital
flight, as was the case during the Asian crisis of 1997 (Suma, 2007). This state of uncertainty
pushes entrepreneurs to adopt a "waiting" behaviour, which pushes the investment in the future. The
contractor adopts the perspective of short-term investments with a focus on a short profitability
horizon that allows him to glimpse a regulations maintain. Moreover, the prospect of a default,
many debt rescheduling and arrears are all factors that may increase the volatility of future funding
and the rates at which they will be made (Presbitero, 2005).

2.3 The decline in economic growth as the cause of debt

Government resources are derived largely from taxes paid by the taxpayer. But these
contributions are based on production or more precisely the income generated from production. In
case of slowdown in economic activity, the state's tax base is reduced and therefore the debt
becomes the only alternative if the state wants to ensure expenses. Thus, if the state is reluctant to
adjust its deficit to slower economic growth, the ratio of debt to GDP will increase, in other words,
a reduction in economic growth will lead to increase the government debt (Easterly, 2001).
From another point of view, achieving good performance in terms of economic growth creates
additional resources that can be applied to reduce existing debt or to avoid debt for investment or
consumption. According to Easterly (2001), slower growth has played an important role in the
HIPC debt problem and helps to explain why the level of debt was sustainable under a previous
growth system has suddenly become unbearable and causes crisis under a new regime of growth.

8
2.4 The empirical analysis of the debt-growth relationship

In the mid-80s, following the insolvency crisis triggered by Mexico, some studies have focused
on analyzing the interaction between external debt and economic growth. Most empirical studies
does not establish a direct link between economic growth and debt, and even when it does, further
study is usually conducted to investigate the impact of debt on the variables that determine theory of
economic growth, including investment.

The analysis of panel data

The analysis of panel data in general concern LDCs, sometimes with regional groupings. These
studies seek to assess the most impact of debt on economic growth and to identify variables against
which it is determined. Many authors have studied this type of analysis and the results are not
unanimous. Chowdhury (1994) uses data spanning the period 1970-1988 and for countries in Asia
and the Pacific (Bangladesh, Indonesia, Malaysia, Philippines, South Korea, Sri Lanka and
Thailand) through a simultaneous equation model to analyze direct and indirect effects of external
debt on GNP and vice versa. The results he obtained show that the effect of public and private
foreign debt on GNP is negligible in the countries concerned. He also rejects the hypothesis of "debt
overhang" and believes that the external debt of these countries is not the main cause of slow
growth. Cohen (1996) conducts a study on a set of countries in Latin America and he found that the
negative impact of external debt on growth is effective in the case of Latin American countries and
is not effective for African countries.

On the other side, other authors such as Iyoha (1999) validate the hypothesis of debt overhang
and crowding out of public investment. Indeed, with an analysis of panel data including 50 sub-
Saharan Africa countries over the period 1971-1994 and using a simultaneous equation method, he
says the stock and service the external debt had a negative effect on investment in sub-Saharan
Africa. He also believes that a reduction of 50% of the stock of external debt in 1986 would have
increased investment by 40% and the rate of GDP growth of 3 %, at least over the period 1987-
1994. Pattillo et al. (2002, 2004) test for the nonlinear effect of debt burden on economic growth
and try to determine the debt threshold at which debt has a negative impact on growth. They believe
that the debt negatively influences economic growth when it reaches 160-170 percent of exports or

9
35-40 percent of GDP. Their results are robust to various econometric methods (Ordinary Least
Squares, Generalized Method of Moments, etc..) and for various debt indicators.

Analyses of individual countries

Few researchers have examined the relationship between debt and economic growth in the case
of individual countries, especially developing countries. Were (2001) examined the case of Kenya
in order to examine the structure of the country's external debt and to determine the impact on
economic growth. His approach is to construct a model with two equations, one explaining the
growth of GDP, the other explaining private investment. It uses cointegration analysis and error
correction model (ECM). His study found that the accumulation of debt, largely from multilateral,
had a negative impact on economic growth and private investment in Kenya, supporting the
hypothesis of the debt overhang. However, these results show that the current debt stimulates
private investment and that debt service does not really affect growth but exerts a crowding out on
private investment.

Karagol (2002) carried out his study on Turkey, its objective is to analyze the causal
relationship between debt and economic growth. To do this, it starts from the neoclassical
production function which productive factors are physical capital, labor and human capital, to which
he adds as a predictor of the country’s external debt. Then, using a VAR model, a cointegration
analysis between different variables and an ECM, it establishes the dynamics of short and long term
variables of the model. The causality test reveals a unidirectional relationship between debt service
and gross national product; it establishes that the debt service has a significant negative effect on
GDP comparable to the debt overhang effect.

Wijeweera (2007) also uses an ECM and a method for estimating cointegration relations in the
short and long term relationship between external debt and economic growth in Sri Lanka in order
to test the hypothesis of the burden of debt as an impediment on economic growth. He concludes
that this effect (debt overhang) would be present through the negative coefficient of debt service
received during the regression, but is not statistically significant, he attributes this lack of
significance to the fact that the debt Sri Lanka has not reached the level where it could have a
negative impact on growth in the long term.

10
 3. DATABASE AND ECONOMETRIC MODELLING OF THE RELATIONSHIP
BETWEEN EXTERNAL DEBT AND ECONOMIC GROWTH

3.1 Presentation of the database

The data used for our analysis come from two sources: first the representation of the World
Bank in Cameroon, and secondly the Autonomous Sinking Fund (CAA). The database of the World
Bank (WB) contains a thousand variables and spans the period 1965-2007. In reference to the
endogenous growth model, we derived the labour variables, domestic investment and literacy. The
data from the CAA are spread over the period (1981-2007) and related variables: the stock of public
external debt, external debt service, GDP, budget revenues of the state, import and export. To
extend this data set, given the type of model we use and the high number of coefficients to estimate,
we used data from the WB. Indeed, we have noticed through a graph representing simultaneously
both series that the data from the WB does not really coincide with data from the CAA, but tended
to evolve in proportion to these (in some cases superiorly and inferiorly in others), this trend seemed
especially plausible in the 80s. Assuming a similar trend during the previous decade, we used the
average ratio between the data from the WB and those coming from the CAA over the period 1981-
1990, to extend our basis to 70s.

The variables ultimately spread over the period 1970-2006 and are taken in logarithmic form,
applying a logarithmic transformation on the variables in the model reduces the effects of scale (risk
of residual heteroscedasticity) and it is consistent with growth models which are in general
multiplicative. The estimated coefficients can thus be interpreted as elasticities of the dependent
variable with respect to the explanatory variables.

3.2 The econometric approach

Besides the method of single equation regressions (simple linear model) to explain a single
variable through a resolution by ordinary least squares (OLS) or the generalized method of
moments (GMM), used by several authors, two other approaches have caught our attention:
- Firstly, the simultaneous equations regression, proposed by Mbanga and Sikod (2001) for
Cameroon, and implement by Were (2001) in the case of Kenya and by Iyoha (1999) on a panel of
Africa Sub-Saharan countries, can take into account the simultaneous interaction between the
variables studied. Specifying this type of model is done with endogenous variables whose date is

11
present, only exogenous variables can be shifted. However this model has the advantage of
facilitating the simulation of economic policies by the perception of the effect of changing the
current value of an endogenous or exogenous variable on the other variables explained.
- On the other hand, VAR (vector autoregression) modelling, implemented by Karagol (2002) in
the case of Turkey and adopted by Wiljeweera (2007) for Sri Lanka, is a specification in which all
variables are endogenous and the regression is performed on lagged values. This specification
allows to capture the interactions among the lagged values of endogenous variables and their
impacts on present values. It also has the advantage of assessing the effect on the current value of an
endogenous variable of an impulse made on a lagged other variable through the impulsionnal
analysis and decomposition of the variance of the target variable. Thus, this model is also
appropriate that the previous to simulate government measures and economic policies. Further, it
seems to be closer to reality because, in general, the effect of economic policy measure is noticeable
after a certain time, in other words, there is a gap (which can be one or more periods) between the
implementation of a reform and the results it implies. For example, investment in period t is
generally done to alter the production of period t +1 and not that of the current period. This model
therefore seems economically more suitable to capture the dynamic interaction between debt and
economic growth.

The specification of the econometric model

We extend the model used by Karagol (2002) assuming that openness to foreign trade is a
pattern of production. The specification that we consider is the following:

Yt =F(K t ;L t ;H t ;OUVt ;D t ;SD t )

With Y t = gross domestic product in period t;

K t = Physical capital stock in period t;

L t = Materialized labour in period t;

H t = The human capital in period t;

OUVt = Represents the opening (export + import) / GDP ratio in period t;

Dt =Stock of debt at time t;

SD t = The debt service at time t.

12
 Model assumptions

The assumptions underlying the model equations defined above are as follows:
- The growing rate of the output is based on those of physical capital, debt, human capital, labour
and the degree of openness of the economy;

- The degree of openness of the economy evolves positively in terms of its production, with the
level of capital and is negatively influenced by the burden of the debt;

- The growing rate of debt is reduced by the production, capital, opening and the debt service;

- The capital grows according to the production and openness of the previous period, and is
negatively affected by increases in the stock of debt and debt service.

To minimize effects of multicollinearity, we have been forced to eliminate variables reflecting the
labor force and human capital. Moreover, these deletions had no significant impact on the model
(R2 almost identical in models constrained and unconstrained).

The variables for the model, after treatment of multicollinearity, are as follows:
- LPIB: logarithm of GDP

- LINVES: logarithm of gross domestic investment

- LOUV_PIB: log of openness ratio calculated as the percentage ratio of the sum of imports and
exports to GDP.

- LRDETTE_PIB: logarithm of the ratio of external debt to GDP

- LRSERVDET_EXP: the logarithm of the ratio of actual service of external debt to exports.

Stationary tests of model variables

Before estimating the model, it is first necessary to verify the stationarity of variables used to get
an idea of additional procedure to performe to correct the model (cointegration, differentiation,
modelisation VECM). For this, we used the KPSS test, Phillips-Perron and Augmented Dickey-
Fuller (ADF). These tests indicate that at α = 5% significance level, all variables considered are
stationary after a differentiation.
Tableau : stationarity test

13
 Source: WB, CAA and our calculations on Eviews

Cointegration analysis

Analysis of the cointegration performed using the Johansen test shows that there is no
cointegration relationship between variables. Therefore, it is necessary to differentiate before their
introduction in the VAR model.

The selection of the lagged number in theVAR model

The selection of the optimal number of delay is done using the selection criteria (LR
(Likelihood Ratio), FPE (Final Prediction Error), Akaike (AIC) Schawrz (STC), Hannan-Quinn
(HQ)) implemented on software Eviews 4:

The maximum possible delay in view of available data has been set at 4, two selection criteria
(LR and EPF) are in favor of an offset, the other two (SC and HQ) are in favour of an offset zero
and another (AIC) supported an offset maximum. We chose to retain as optimal lag the one
recommended by the greatest number of criteria. Therefore, we had a choice between 0 and 1 offset.
The choice of 0 would have led to perform a regression on the constant, which does not help us in
our study. In addition, some researchers recommend the LR test as the most suitable for selection.
We have therefore retained a delay for our model.

Table: Selection test of the lagged number in the VAR model

Source: WB, CAA and our calculations on Eviews.

14
4. RESULTS AND INTERPRETATION

4.1 Estimation and interpretation of model

The VAR model has allowed us to estimate 30 coefficients for our model, of which 11 are
significant at 10%.
Table: Results of the VAR model

Source: WB, CAA and our calculations on Eviews.

The GDP’s equation

The GDP’s equation reveals that the growing rate of GDP is positively influenced by GDP‘s
growing rate of the previous period and by the increase of the debt of that earlier period, and
negatively by the growing rate of the debt service in the previous period. All things being equal, an
increase of 1% in the growing rate of GDP in the previous period leads to an increase of 0.54% of
that in the next period, an increase of 1% in the growing rate of debt stock leads to an increase of
0.31% of the growing rate of GDP and a 1% increase in the growing rate of debt service results in a
reduction of 0.11% of the growing rate of GDP. The positive rate of growth of the past period is
consistent with the theory of endogenous growth and dynamics of the growth process. Contrary to
our expectations, the influence of the growing rate of investment of the last period on the current
growing rate of GDP is not significant. Moreover, the growing rate of the opening of the previous
period reduces the GDP growing rate of the current period (All things being equal, an increase from
1% growth rate of opening causes a reduction of 0.34 % the GDP of growing rate). The positive
impact of debt does not appear to be consistent with the assumption of debt overhan. Indeed, this
positive relationship between the growing rate of debt and the GDP growth table for the hypothesis
that Cameroon would be in the left side of the Laffer curve, where growth is positively related to
debt. However, according to the Laffer curve, the positive relationship between the growing rate of

15
GDP and the debt is likely to reverse beyond a certain threshold of the outstanding debt. Moreover,
like other cyclical variables of economic policy such as budget deficit or the inflation rate, the
short-term debt is acting on the effective output and not on the potential output which correspond to
production capacity, so the positive impact of debt on growth could then be seen as evidence of a
sub-optimal allocation of funds borrowed (e.g. to consumption). We also observed the presence of
the negative effect of increasing external tax on GDP growth through the debt service.

The investment equation

The growing rate of investment in the current period is positively related to that of the
previous period and to the growing rate of the opening. All things being equal, a 1% increase in the
growing rate of investment in the previous period leads to an increase of 0.43% of that of the next
period, an increase of 1% in the growing rate of opening leads to an increase of 0.48% growing rate
of investment. The effects of debt and its service, although negative in accordance with our
expectations, are not statistically significant. The non-significance of the coefficient of debt shows
that it does not finance investment and actually seems to confirm the hypothesis that the positive
effect on the recorded growth rate of GDP is based on consumer spending.

The equation of the opening

The country's openness is positively influenced by the growth of GDP and the debt of the
previous period. The increased investment and servicing of external debt reduced opening. Indeed,
the increased debt service reduces the level of foreign currencies available to the country to
purchase international trade. The negative impact of investment on the opening seems paradoxical.

The equations of debt and debt service

The rate of investment growth from the previous period reduces the growth rate of the debt of
the current period, which could be interpreted as a return on investment that generates funds to
make expenditures that less recourse to external debt financing. We also noted, although this is not
significant, the debt service contributes positively to the growth rate of debt.
Thus, in the Cameroon case, we can look to this model confirm the hypothesis of liquidity
constraints due to the tax created by the external service the debt. For cons, the assumption virtual
burden of debt does not seem to be corroborated by our model. Moreover, the impact of external
opening both positive on investment and negative on GDP issue the question of externalities
generated by exported commodities (Dutch disease) and the strategy of opening the country, so that
gains made on investment, especially for export activities, may be reflected at the level of GDP.
Indeed, a perverse effect of openness to foreign trade can be expressed through the Dutch disease
with leads to promote the growing export activities, especially production (oil, timber, etc..), and to
neglect other industries (food and chemical industries), thereby promoting the growth of real
exchange rate and further weaken the competitiveness of other industries.

4.2 The analysis of causality

16
 The causality can give an idea on the contribution of one variable to the prediction of another.
Thus, a variable is the "cause" to another if his knowledge improves the one of the other (allows to
better predict it). The causality analysis also refers to the concept of exogeneity of the model
variables, those being the cause of others may be regarded as exogenous. In practice, analysis of
causality has led to several concepts of causality (Granger causality, Sims, etc..), In connection with
the testing method used. We used for our model the Granger causality test, which is based on
significance of the coefficients from the regression of presumed dependent on its lagged values and
those of the variable assumed exogenous. The Granger causality test allows us to retain six causal
relationships between variables in the model. The most exogenous variable seems to be the growing
rate of debt service. Thus, the debt service determines the opening, the opening determines the
investment, the investment determines the debt and debt influences the growing rate of GDP. We
also note that there is one relationship ("feedback effect") between openness and investment, and
the influence of investment on GDP seems to be realized through the opening to foreign trade.
Table: Test for Granger Causality

Source: WB, CAA and our calculations on Eviews.

4.3 The impulse response analysis and variance decomposition

One of the main advantages of VAR modeling is to facilitate the analysis of impulse response
functions and simulation of economic policies. The impulse response function represents the effect
of a shock or a pulse on the present and future values of endogenous variables (Mignon and Lardic,
1999). This analysis uses the concept of exogenous variables in the model. It's actually supposed to
specify the variables to be altered in economic policy and that the change could have a direct effect
(current) on the other variables before spreading into the future. Indeed, in practice, the residuals
from different equations of the VAR model are correlated, which causes a change in the current
values of other variables during a pulse. Thus, the variable chosen for the pulse is critical and
determines the responses of other variables. It is recommended to rely on economic theory or at the
instigation, ordering more exogenous variables to more endogenous (op. quote, 1999).
Table : Impulse Response Functions

17
 Source: WB, CAA and our calculations on Eviews.

Referring to the order established by the Granger causality test (see above), the impulse analysis
reveals an increase of 35% (standard deviation shock of 1%) of debt service leads instantly: a
reduction of about 4% of the opening, an increase of about 4% of the investment, an increase of
about 10% of the debt and a reduction of almost 1% of GDP, these effects dissipate between 5 and 8
years. The payment of debt service is seen as evidence of reliability enables the lender to contract
new loans and new investment. The positive effect of this investment to GDP is transmitted with
three years of delay. By cons, a negative shock to one standard deviation (a reduction of
approximately 35%) of debt service, other things being equal, results in an immediate increase in
GDP of about 1.23%, a reduction in debt of 9.76% and a reduction in investment of 4.2%. We
observed that after two years, the rate of growth of GDP becomes negative as well as the other
variables in the model. Indeed, the blow we have simulated and can be interpreted as a situation of
moral hazard in which the country refuses to honour its debt service, which immediately leads to a
reduction in lending. The decrease in growth rates of different variables after 2 years shows the
importance of debt for our economy and shows that a default decided unilaterally would not be
beneficial in medium and even in short-term for our economy. Should we make a negative shock to
one standard deviation (35%) on the debt service and positive one standard deviation (16.7%) on
debt (cancellation of debt with concerted new lending), then the GDP growing at an average rate of
3% over the two years thereafter. If on the two previous shocks, we add a positive impact on
investment of a standard deviation (8.7%) then the average growth rate of GDP over two years will
be around 7.52%.
18
 This analysis reveals the importance of investment and debt for the Cameroonian economy and
the burden of servicing this debt. It can be complemented by an analysis of variance decomposition
of forecast error. It is actually to identify the contribution of each variable to the forecast error of
another, in order to determine which variables are most appropriate to influence another.
The variance of the prediction error rate of GDP growth is due to 43.50% to its own innovations, to
20.28% of the growing rate of debt, 15.98% of the growing rate of opening and to 15.57% of the
growing rate of investment and 4.71% from those of the growing rate of debt service. We deduce
that a shock affecting the growing rate of debt has more influence on the growing rate of GDP than
shocks on other variables. By cons, a shock to GDP has very little influence on the change in debt.
This reflects the importance of funds from the debt for the country's economic growth and helps to
understand the upward trend experienced by the country's foreign debt despite periods of positive
growth.
Table: Variance Decomposition of forecast error

Source: WB, CAA and our calculations on Eviews.

5. CONCLUSION

The main objective of our study was to assess the relationship between debt and economic growth
in the case of Cameroon. Specifically, we were testing the assumptions of the debt overhang and the
crowding out of public investment. Since, according to economic theory, the debt may have
perverse effects on the economy resulting as discouragement of investment and a failed policy of
increasing consumption. For this, we used a model based on an approach VAR (vector auto
regressive) implemented by Karagol (2002) in the case of Turkey. Our model is based on four
variables, namely GDP, investment, stock of public external debt and the servicing of external debt.
The different stationary tests implemented validated the first-difference stationary variable model
and analysis of cointegration between variable did not reveal any cointegration relationship, the
model was estimated in first difference. The results refute the hypothesis of the debt overhang and
tend to confirm the effect of crowding out of investment in general. The debt would have even a
positive impact on growth, indicating that the country is on the left side of the Laffer curve. In fact,
Cameroon will need additional funds from outside in order to better exploit their productive
potential and, any reduction in debt stock would be beneficial only through the reduction of debt
service and new lending opportunities it offers. In addition, a brief historical overview of the
Cameroonian economy shows that the main factors increasing the debt crisis of 1987 and the

19
devaluation of the CFA franc. Thus, the high level of debt does not result from a “waste” of
borrowed funds but rather to external shocks, hence the profitability of additional loans. The debt
relief granted under the HIPC Initiative thus suggest an optimistic outlook given the release of
resources used for debt service.

At the end of our study, we recommend the following:

1. To the Government

- Enhance the measures for the improvement of the management of public funds;

- Strengthen mechanisms to enhance the productive potential available in the country,

including the reduction of bureaucratic procedures, the effectiveness of the financial market of
Douala and improving public infrastructure;

- Visibly encourage entrepreneurship, including through the restructuring of the business

environment in general and particularly the protection of emerging companies, facilitating
their financing and taxation to promote the growth of SMEs, for export diversification and to
reduce vulnerability to external shocks;

- Improve the forecasting of revenues and expenditures of the State to better plan future loans
that would be beneficial to contract at concessional rates and referrals to viable projects, from
a pre-established participatory diagnosis with users to limit the risks of wastage.

2. To population and custodians of the HIPC Initiative:

- Develop the cult of ethics, for better management of public property;

- Ownership of all development projects in their locality to reduce social inequalities and
poverty;
- Further reduce the external debt of the country, especially his service, and facilitate access to
concessional loans.

20
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Annexe :

Figure 1: Evolution of the growth rates of GDP and external debt in Cameroon

Source: BEAC et CAA

Figure 2: Contribution of debt to GDP growth (modified debt Laffer curve)

24
 Source: Cordella & all (2005)

Table 1: debt service and budget allocated to social service in percentage of total budget under 1992-1997
period

Means in percentage of states’ budgets

Country Social services Debt service
Cameroon 4% 36 %
Ivory Coast 11,4 % 35 %
Kenya 12,6 % 40 %
Zambia 6,7 % 40 %
Niger 20,4 % 33 %
Nicaragua 9,2 % 14,1 %
Source : CADTM (2006)

25